Does Federal Hydro-Generating Company - RusHydro (MCX:HYDR) Have A Healthy Balance Sheet?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Public Joint-Stock Company Federal Hydro-Generating Company - RusHydro (MCX:HYDR) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Federal Hydro-Generating Company - RusHydro

What Is Federal Hydro-Generating Company - RusHydro's Debt?

As you can see below, Federal Hydro-Generating Company - RusHydro had ₽174.2b of debt at March 2021, down from ₽193.1b a year prior. However, because it has a cash reserve of ₽99.1b, its net debt is less, at about ₽75.1b.

A Look At Federal Hydro-Generating Company - RusHydro's Liabilities

We can see from the most recent balance sheet that Federal Hydro-Generating Company - RusHydro had liabilities of ₽151.0b falling due within a year, and liabilities of ₽165.2b due beyond that. On the other hand, it had cash of ₽99.1b and ₽59.0b worth of receivables due within a year. So its liabilities total ₽158.2b more than the combination of its cash and short-term receivables.

Federal Hydro-Generating Company - RusHydro has a market capitalization of ₽360.1b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Federal Hydro-Generating Company - RusHydro's net debt is only 0.64 times its EBITDA. And its EBIT covers its interest expense a whopping 98.3 times over. So we're pretty relaxed about its super-conservative use of debt. And we also note warmly that Federal Hydro-Generating Company - RusHydro grew its EBIT by 13% last year, making its debt load easier to handle. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Federal Hydro-Generating Company - RusHydro's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Looking at the most recent three years, Federal Hydro-Generating Company - RusHydro recorded free cash flow of 26% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

The good news is that Federal Hydro-Generating Company - RusHydro's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But, on a more sombre note, we are a little concerned by its conversion of EBIT to free cash flow. We would also note that Electric Utilities industry companies like Federal Hydro-Generating Company - RusHydro commonly do use debt without problems. All these things considered, it appears that Federal Hydro-Generating Company - RusHydro can comfortably handle its current debt levels. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Federal Hydro-Generating Company - RusHydro you should know about.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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